The new mortgage refinancing program buys into the idea that the government must intervene in the foreclosure crisis.
President Obama's recently announced housing plan contains a number of excellent proposals that should help Americans struggling to make ends meet. Simplifying lending documents, streamlining the refinancing process, providing funding for innovative local interventions, and increasing the incentives for private loan modification are wise and necessary initiatives.
Many of the key parts of the plan appear specially designed to circumvent the private sector's failure to act in its own best interest. Private lenders have not had high participation rates in any of the previous incentive-based programs and have opted to foreclose in many instances where there is a more economically rational option. There have already been two million foreclosures since the beginning of the housing crisis and another two million mortgages are seriously delinquent or already in the process of being foreclosed.
In an effort to reduce the high rate of foreclosure, the major refinancing initiative proposes to shift the risk associated with underwater loans from the private sector to taxpayers. The FHA would purchase underwater mortgages from private lenders at 100 percent of the current loan amount, refinance them at lower rates, and assume the risk of those loans defaulting. This is a dream scenario for banks; they get the full amount of a loan that, if it remained on their books, would be very likely to default.
In return for having the FHA assuming its riskiest mortgages, it makes sense that banks help fund the initiative. While the "new tax" on financial institutions intended to fund this program will be hard to pass, it is only equitable that the banks pay for this part of the plan. The tax should be calibrated to reflect the risk that taxpayers are assuming when the FHA buys the underwater mortgages. Otherwise, the FHA refinancing plan will become just another bank bailout.
Meanwhile, although reducing homeowners' monthly payments will affect the default rate, this plan does nothing to reduce the principle owed. As a result, homeowners will continue to walk away from homes that are underwater. In the third quarter of 2011, CoreLogic estimated that 10.7 million, or 22.1 percent, of all residential properties were still in negative equity. Principle reduction should be part of any serious housing proposal. In this regard, President Obama's proposal does not go far enough.
Another part of the plan was a proposal to convert some real estate owned (REO) property held by Fannie Mae and Freddie Mac into rental property. This makes a lot of sense simply because we have a surplus of empty houses and a shortage of rental properties. But why aren't homeowners already being offered the opportunity to remain in the house as renters? Institutional lenders aren't designed to be landlords (like they aren't designed to modify mortgages), but this is an opportunity for investors and management companies to fill the obvious gap. Hiring companies to manage the properties could also create local jobs, which would have an added economic stimulus.
While I wish the plan were stronger, it contains some very worthwhile proposals that will help millions of American homeowners be able to afford their mortgages. It's a pity that it is being so poorly received by Republicans in Congress. There should be a rigorous debate in Congress about the most effective intervention, not about whether intervention should take place at all.
Kristen Tullos is a Roosevelt Institute Pipeline | Fellow and a third-year student at Emory Law School in Atlanta .